Henderson legal case highlights social housing risk

Nearly 30 pension funds have filed claims at the High Court seeking damages from Henderson Global Investors over claims it took too much risk with one of its funds, the Henderson PFI Secondary Fund II, when it used the majority of the fund’s assets to buy John Laing, a firm with a large pension deficit.

The fund subsequently lost 2/3rds of its value, not least because of the pension scheme deficit. Now I’m not seeking to comment on this case specifically and indeed Henderson’s have signalled they “will vigorously defend these proceedings” but more on some wider pension related implications.

I would have expected that at least when conducting due diligence on the investment Henderson would at least have been aware of the existence of a defined benefit pension liability via accounting disclosures under FRS17 in John Laing’s company accounts. Whilst the FRS17 position would significantly under-estimate the position at least its presence in the accounts would allow investors to make some broad assessment of the risk involved in any transaction and indeed to take professional advice where necessary.

A similar ‘low risk’ asset class is being widely promoted in the market at present, namely that of investment in Social Housing, seen as a new source of long dated, inflation linked cash flows for pension funds now that access to significant levels of similar government securities has all but dried up. However, as a source of pension investment is it precisely the level of pension risk these organisations face which mean these investments may not represent quite as low risk an asset class as at first glance they appear.

Over 150 housing associations in Scotland and around 600 in England and Wales participate in social housing pension schemes related specifically to the sector. These are defined benefit arrangements and both are running very significant scheme deficits. At the last valuation in 2009 the Scottish Housing Association Pension Scheme (“SHAPS”) in Scotland had an on-going deficit of around £160m and a buyout deficit of around £340m while the Social Housing Pension Scheme (“SHPS”) in England and Wales at the last valuation in 2008 had an on-going deficit of around £620m and a £3.4bn buyout deficit. The funding position of both schemes is likely to have further deteriorated to the current date.

A major difficulty is that participants within these schemes do not tend to fully comply with the requirements of FRS17 and so do not disclose their scheme deficit and offset this against their balance sheet value. The schemes use a ‘multi-employer’ exemption under FRS17 which means that if they cannot identify their share of the assets and liabilities under the scheme they can disclose as if the scheme was a defined contribution arrangement, that is purely confirm the contributions paid.

Most, if not all leading auditors, are uncomfortable with the approach being taken as they have concerns that the exclusion of the full disclosures mean that associations are not making a ‘true and fair’ representation of their financial position. Organisations who participate in local government schemes could also adopt the exemption however most chose not to. This leads to the inconsistent and unjustifiable position where two similar organisations with a similar pension deficit show wildly different net balance sheet positions.

The SHPS and SHAPS schemes are likely to move towards a basis where deficit contributions will be based upon each associations specific share of the overall liabilities which will make anything but full disclosure less likely. This will undoubtedly mean associations having to bring very significant pensions deficits on to their balance sheets over the next few years with a potentially dramatic impact on their financial position.

Investors in Social Housing products will need to understand the extent to which investment managers have researched this issue, given the lack of accounting transparency, and if it represents an increased level of risk exposure to that suggested.

In addition as income streams to these investment products are deemed preferential over other association expenditure, in a similar way to PFI type investments, the associations themselves will want to understand the implications for their organisations, especially should pension contributions rise or other income fall.

At least in the Henderson case it is likely the pension deficit issue was more transparent and therefore easily assessed. Those using social housing investment will want to be confident that despite the lack of transparency the issue has been properly investigated.